A Currency Deal with China?

While running for president in 2016, Donald Trump pledged that “on day one of a Trump Administration the US Treasury Department will designate China a currency manipulator.” As recently as August 2018, the president tweeted that China’s practices were hurting US interests: “I think China’s manipulating their currency, absolutely.” It is thus highly ironic (to put it mildly) that he may now be asking China to manipulate its exchange rate to help the United States.

Where you stand depends on where you sit. As with the North American Free Trade Agreement (NAFTA), Trump wants to trash his predecessors in the Obama and Bush administrations while defending his own position when the two are in fact largely indistinguishable. The United States has long wanted China to stop buying dollars to keep the Chinese currency, the renminbi (RMB), from strengthening—as China did massively during 2003–13 but has not done since. According to press reports, China may now “pledge to keep the RMB steady.” The logical inference is that, under pressure from Washington, it would buy its own currency and sell dollars to keep the RMB from falling even if market forces pushed it down. (Brad Setser of the Council on Foreign Relations, a former Treasury Department economist, notes that “I don’t see how you can credibly try to bring the bilateral deficit down if China doesn’t make a commitment to resist further depreciation.)

The difference would be in the direction of the manipulation, with China selling dollars rather than simply not buying them. But the goal is the same: to hurt China’s competitive position because a stronger RMB raises the prices of Chinese exports and lowers the prices of its imports. Anything less would hardly justify Secretary of the Treasury Steven Mnuchin’s claim that this would be “one of the strongest agreements ever on currency.”

Trump has long been upset about the US bilateral trade deficit with China, which actually rose to a record $419 billion in 2018, despite his imposing tariffs on $250 billion worth of imports from China. But as this trend indicates, it is always misguided thinking to try to use trade agreements and tariffs to alter trade balances. Trade balances reflect countries’ underlying economic conditions, notably the relationship between their national saving and investment levels. Such imbalances cannot be much affected by changes in tariffs and other trade policy instruments. This is particularly true of bilateral trade balances, as between the United States and China, which are merely shuffled around if trade agreements produce shifts in flows between the two countries (as they can).

But Trump seems determined to seek reductions in the large US bilateral deficit with China and appears willing to accept China’s promises to increase its imports of some US products, such as soybeans and liquefied natural gas. He has also sought to reduce US imports from China through his beloved tariffs. Such trade shifts are likely to lead market forces to push the dollar up and the RMB down, at least in the short run, offsetting their impact on the overall balance. Within the context of Trump’s misguided trade policy, there is thus a superficial logic in seeking a Chinese commitment to keep its currency from falling.

There is no doubt that China could fulfill such a pledge. Its foreign exchange reserves exceed $3 trillion so it can buy lots of its own currency to prop it up. China in fact sold about $1 trillion from its dollar reserves during 2014–15 to limit the decline of its currency at that time, when market forces were pushing it down sharply. This part of the pending trade agreement would be readily enforceable in light of the instantaneous real-time observations of exchange rate changes.

Some observers have suggested that such a currency commitment would be easy for China to make since it does not want the RMB to depreciate anyway because it would reflect badly on the state of China’s economy. For example, China sought to counter the sharp weakening of its currency in 2014–15 when sizable capital flight jeopardized confidence in the country’s economic health and economic management.

However, China is not eager to see its trade surplus, which has already declined to less than 1 percent of its GDP, fall further and was quite content with the modest RMB depreciation against the dollar over the past year or so. If China were to hold the RMB constant against the dollar and the dollar were to continue to rise against other currencies, such as the euro and yen, the RMB would be pulled up against them. China’s overall competitiveness and global trade balance would decline as a result.

Hence any nondepreciation commitment made by China in the context of a new trade agreement should be regarded as at least modestly meaningful, as was its willingness to let the RMB rise by more than 40 percent against the dollar from 2005 to 2014. A weaker version of the commitment would be for China simply to pledge not to push the RMB down through intervention in the currency markets in an overt effort to offset any US bilateral trade balance gains from expanded exports or reduced imports. An even weaker version, echoing agreements reached earlier in the G-7 and G-20 and embodied in the new US-Mexico-Canada Agreement, would only require consultations between China and the United States if either were to intervene directly in the currency markets.

If there is a new United States–China trade agreement, it will hopefully deal primarily with the structural problems afflicting China’s trade policy including forced technology transfer, theft of intellectual property, cyberespionage, and government subsidies to state-owned enterprises. But if it includes a large dose of managed trade, including a green light for currency manipulation, it would mark a recrudescence of previous erroneous policies, though it would probably be less bad than the likely alternative of all-out trade warfare.